Emerging Market Currencies Get “Trumpled”

In the wake of the largely unexpected election win by Donald Trump, markets have reacted in some interesting ways. The US market reacted initially with a sell-off, but then whip-sawed into a mild relief rally. Treasuries are selling off and yields are rising on the back of what commentators are suggesting is the Trump “regime change”. Why is this happening? Markets are expecting growth and inflation from Trump’s proposed spending plans which would likely be funded by government bond issuance.

Indeed the sell-off is being seen in other markets too, especially emerging market currencies and bonds. (Source for all charts: Bloomberg)

Regarding specific currencies, the drops that have occurred in the Mexican Peso are easily understood: Trump’s rhetoric on the campaign trail was directed at the economic relationship between the US and Mexico, specifically he pledged to repeal NAFTA and renegotiate trade between the nations. But the sharp drops in the Rand are somewhat surprising. Indeed, in the two trading days since the election result was known, the Rand lost 7%. For comparison’s sake, over the same period the JP Morgan Emerging Market Currency Index (pictured above) lost 1.67%.

The market’s reaction is, in our opinion, based on three possible factors:

Trump’s Trade – Donald Trump campaigned on an anti-trade platform, which would be relatively bad news for trade-intensive emerging markets such as South Africa and could impact other emerging market currencies and assets.

Investor Uncertainty – With Donald Trump comes a number of questions: Which of his policies will be implemented? To what extent will the rhetoric match reality? This uncertainty tends to create demand for safer assets, reversing portfolio flows into South Africa.

The Fed – The market has begun to price in inflation again, and this should improve the probability of a rate hike. If markets continue to be optimistic, we think the Fed will more than likely raise rates.

The chart below displays the annualized volatility in the Rand since 2000. Since 2000, this year has been the second most volatile, after 2008.

The chart below compares 1 month at-the-money implied volatilities for the Rand and the Peso (against the Dollar).

With all of the political risk and credit downgrade fears swirling in South Africa this year, these charts could make sense. But it is still a bizarre result, considering the US is Mexico’s biggest trading partner and that they were holding an election, with one candidate from a major party essentially hostile to said trading relationship.